It began more than 90 years ago as a small tax break intended to help
family farmers who wanted to swap horses and land. Farmers who sold
property, livestock or equipment were allowed to avoid paying capital
gains taxes, as long as they used the proceeds to replace or upgrade
their assets.

Over the years, however, as the rules were loosened, the practice of exchanging one asset for another without incurring taxes spread to everyone from commercial real estate developers and art collectors to major corporations. It provides subsidies for rental truck fleets and investment property, vacation homes, oil wells and thoroughbred racehorses, and diverts billions of dollars in potential tax revenue from the Treasury each year.

Yet even with those generous terms, some major American companies — including Cendant, Wells Fargo and General Electric — have routinely pushed the boundaries while claiming lucrative tax savings, according to evidence recently presented at a federal trial in New York. ...

With hundreds of thousands of transactions a year, it is hard to gauge the true cost of the tax break for so-called like-kind exchanges, like those used by Cendant, General Electric and Wells Fargo. The government estimates that it diverts less than $3 billion a year from the Treasury, but industry statistics suggest the number could be far higher.

The tax break also exposes one of the greatest vulnerabilities of the United States tax system: it depends on voluntary compliance. The IRS staff is so outnumbered by tax lawyers and accounting departments at major corporations that there is often little to prevent taxpayers from taking a freewheeling approach to interpreting and administering the rules. ...

Some financial planners and economists say that the tax break even favors real estate investors unfairly by allowing them to defer capital gains taxes that those who invest in securities and other ventures have to pay. And although it was originally intended to help farmers, some economists and lawmakers in agricultural areas say it has perversely contributed to suburban sprawl and the spiraling cost of farmland. Because it allows farmers to avoid capital gains taxes on land swaps, the tax break provides an incentive to sell farmland coveted by developers and buy property in less desirable and more remote areas.

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Comments

Interesting tax break. How do these large corporations find these tax loopholes? Do they have their accountants searching ancient records to find a tax break that applied to farmers 90 years ago and find a way to legally apply this tax break to their corporation? Amazing, and sad.

These loopholes are not hard to find. The section 1031 loophole is like a prototype tax subsidy for renewable energy insofar as it has been nurtured for decades by tax lawyers who endlessly cycle through the revolving door at Treasury and the IRS. No one has the political guts to shut it down.

Posted by: Jake | Jan 7, 2013 6:59:28 PM

Searching "ancient records" is rarely necessary in tax work. Like kind exchanges have been substantially liberalized over the last 30-40 years. They did not come out of left field.

Posted by: Brian | Jan 8, 2013 12:27:51 AM

As a CPA we have used them for years, especially in Real Estate. Remember, it is tax deferred, not tax free. When you trade in a business car for a new car you are essentially doing a "like kind exchange". But most exchanges are done through a qualified intermediary and are encumbered with a lot of rules to qualify. It is not such a give away as the article made it out to be.